Tuesday, March 20, 2018

The US Pension Squeeze?

Elizabeth Bauer of Forbes reports, Keep On Squeezin', Squeezy The Pension Python:
Illinois voters may remember Squeezy the Pension Python, the main character in a video meant to gain public support for pension reform legislation in 2012.

The bill passed in 2013.  As described by CNN at the time,
The plan will reduce annual cost-of-living increases for retirees, raise the retirement age for workers 45 and under, and impose a limit on pensions for the highest-paid workers.

Employees will contribute 1% less out of their paychecks under the reform, while some will be given the option to contribute to a 401(k)-style plan.

Legislative leaders of both parties crafted the deal, which they say will save $160 billion over the next three decades -- savings desperately needed to help fill the state's $100 billion pension shortfall.
Alas, it was found unconstitutional in 2015, and no action has been taken by the legislature with respect to public pensions in the meantime.  Illinois' funded ratio now stands at 40%, a slight improvement over its 2016 funded ratio of 39%, which placed it fourth most underfunded in the nation.  In dollars, its pension underfunding stands at $130 billion.

And today Illinois will be choosing its nominees for governor, among them a man who was among those spearheading that 2013 pension law, Democratic State Senator Daniel Biss.  In any ordinary set of circumstances, "I tried to reform the Illinois pension system" would be a resume-booster.  Instead, he's apologizing for it.  According to the suburban Chicago Daily Herald,
"The state's got awful budget problems, and state pension debt is an awful part of it," said Biss, a co-sponsor of the 2013 legislation. "I do think there was kind of an obsessive hysteria about it a few years ago that led a lot of people in the legislature, myself included, to act irresponsibly. That bill was unconstitutional."
His opponent, billionaire front-runner J.B. Pritzker, has been running ads attacking Biss for his vote.  The Chicago Tribune provides the text:
“Dan Biss says he’s a proven progressive,” a narrator says. “Ok. Let’s check his record. Biss wrote the law that slashed pension benefits owed to teachers, nurses and state workers. The court ruled it unconstitutional. Dan Biss. Take a look for yourself.”
The ad then directs voters to the Pritzker-created website danbiss.net, where one is told,
In 2013, Biss helped write the bill that unconstitutionally stripped hundreds of thousands of teachers, nurses, and state workers of benefits promised to them. Biss admitted on the Senate floor that his pension cut efforts were unfair and broke a promise to workers. He led the charge for them anyway.
Solving the pension funding issues in Illinois will not be an easy task, after so many years of underfunded and overpromised benefits, of pension spiking and other boosts, and missed contributions to direct state funds elsewhere. But using an honest attempt to solve the problem as a basis for attacks will surely set the state back even further, by constraining legislators even further in terms of the range of options they're willing to consider if they wish to preserve their future political careers.

To be sure, there's a lot more going on in today's primary than simply Biss's support for pension reform. Polls suggest that it would be quite an upset for Pritzker to lose the Democratic nomination, and, either way, there will be no way of saying that it's because of or despite this issue, or whether it really mattered to voters at all. But it's one more indicator that Illinois has a long way to go on the path towards financial health and good governance if indeed it chooses to take that path.
I've already covered America's pension shithole, no need to restate how Illinois, Kentucky and a few other states are getting squeezed to death by their pension obligations. And they are textbook examples of what can go wrong with public pensions when they are ignored, mismanaged, and not operating under the right governance model.

Governance. Everyone loves attacking public pensions, bringing up Squeezy the pension python. What about the big squeeze on fees US public pensions have endured over the last couple of decades from hedge funds and private equity funds?

That's ok, that's justifiable given the returns these titans of finance have produced over the years. Well, it turns out some delivered alpha when it was needed but most didn't, and following the 2008 crisis, pensions were better off plowing money in equity indexes than most hedge funds and private equity funds which received big fees for their lackluster long-term performance.

So, go ahead, blame US public pensions, not saying they don't share part of the blame with their rosy investment projections and refusal to lower their discount rate and introduce a shared-risk model to sustain their pensions over the long run.

But Squeezy the pension python is only part of the problem, there are several structural factors explaining why many US public pensions are chronically underfunded, and governance is a big factor that is often overlooked and misunderstood.

Lastly, one of my astute blog readers sent me his thoughts on US public pension plans:
US public sector pension plans aren't really pension plans. They are clever ways to unjustly enrich public servants at public expense. To achieve this end, the plans have adopted unsustainable funding and accounting practices made possible by inadequate actuarial and accounting standards. The weakest plans are well past the point of no return. The end game will likely begin in the next recession.

The way the courts interpret the pension promise may be legally sound but it is economically absurd. The states are told that, once they allow employees to participate in a pension plan, they cannot reduce the pensions employees have earned prior to the change (reasonable), nor can they reduce the pensions that employees will earn throughout the remainder of their careers (absurd). This being the case (and I believe that Jerry Brown is challenging this interpretation in California, now that he has decided not to seek reelection), the only way to fix a pension plan that has become too expensive due to low interest rates, increasing life expectancies and/or ill-advised pension negotiations (for example, agreeing to pension "spiking") is to dismiss all of the employees (if the court permits states to fire those it can no longer afford to employ) and start again with a DC plan or a Target Benefit plan.

It comes as no surprise that the proposal to borrow $100 billion to take a flier in the stock market enjoys the support of public sector unions. They bear none of the risks and collect all of the money. As long as they can keep the game going, they win and the public is left holding the bag.
You might not agree with him -- and I don't agree that US public pensions are "clever ways to unjustly enrich public servants at public expense" -- but he brings up a good point on the need for all stakeholders to share the risk of the pension plan.

I happen to think that public sector employees deserve to see their pension promise fulfilled. Importantly, a considerable portion of their salary goes to paying their pension contributions so they deserve to know how their pension is being managed or mismanaged, and they deserve to retire with dignity and security.

I hate when people tell me: "Well, let them have what we have in the private sector, no pension at all". What an absurd and shortsighted response. Two wrongs don't make a right. Instead of bolstering pensions for all, we are looking to dismantle public sector pensions, a policy which will only lead to more retirement insecurity, exacerbate rising inequality and weaken the economy over the long run.

So forget about Squeezy the pension python. Let's instead come up with sound public policies that bolster defined-benefit pensions for all. And for Pete's sake, spread the risks of these public pensions across all stakeholders equally in order to sustain them for many years to come.

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